The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Monday, July 22, 2013

Happy Birthday Dodd-Frank: a law that was designed not to and isn't working

In his Huffington Post column, former Senator Ted Kaufman looks at how the Dodd-Frank Act was designed not to address the causes of our current financial crisis and fails to make a future financial crisis less likely.

Failure was built into Dodd-Frank from the beginning. Instead of writing laws that addressed the abuses that led to the crisis, it nearly always kicked the can down to agencies, instructing them to write new regulations.

Regular readers know that by definition Dodd-Frank could not address the causes of the financial crisis because it was completed prior to the conclusion of any inquiry into the actual causes.

Instead, Dodd-Frank, with the notable exception of the Consumer Financial Protection Bureau and the Volcker Rule, was written by the bank lobbyists for the benefit of the banks.

The US is not alone in pursuing bank friendly reform legislation.

In the UK, Parliament is just taking up financial reform legislation almost 6 years after the financial crisis began. There have been two commissions that looked into the crisis: the Vickers Commission and the Commission on Banking Standards. By and large, the proposed financial reform legislation either ignores or adopts a weakened version of the recommendations made by the commissions.

By and large, those regulatory agencies have been overwhelmed by a combination of congressional underfunding and a massive lobbying effort by the megabanks that increasingly seem to control Washington....

When Dodd-Frank was being drafted, the bank lobbyists knew that the regulatory rule making process favored their positions.

Regulatory rule making favors the banks for 3 reasons: money, known by regulators, and act together.

Supporters of financial reform tend not to have the same financial resources, tend not to be known by the regulators and tend to focus only on the financial reforms of interest.

So making the regulators work on a large number of rule makings was intentional.

Here are just a few examples of Dodd-Frank's failure:

• The banks still are gambling with FDIC-insured money. The JPMorgan Chase "London Whale" fiasco was just the latest proof that there has been no change in the casino speculation of Wall Street banks.

• There is still a giant loophole in derivatives trading. Although there are new regulations curbing the kind of derivatives trading that was a key element in the crisis, those regulations do not cover the foreign subsidiaries of megabanks. Banks can easily move trading activities into different offices. He wasn't called the "London Whale" because he worked in Philadelphia.

• No one has gone to jail. And no one will. There are many examples of criminal behavior during the meltdown, but not one megabank executive has been jailed. Without that deterrent, white-collar crime is not just profitable but inevitable.

• Reform of the credit-rating agencies is a long way off. "Essential cogs in the wheel of financial destruction," as the Financial Crisis Inquiry Commission described them, the credit-rating agencies still operate as they always have, bought and paid for by the entities they rate.

• Fannie Mae and Freddy Mac have not been fixed. In fact, they weren't even mentioned in Dodd-Frank, despite the fact that everyone agrees they played a role in the meltdown.

Regular readers know that brining transparency back to the financial system would fix four of these failures.

It would end banks making proprietary bets. JP Morgan showed with its closing out the London Whale trade when it became known to the market that transparency ends proprietary betting.

It would end concern over where derivatives are traded. With transparency, banks must disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details. So derivatives traded in London would still be disclosed and investors could adjust the cost of the bank's funding to reflect these derivatives.

It would reform the credit rating firms by making them just another voice offering their views on an investment. When market participants have access to the same data as the credit rating firms, market participants can independently assess the risk and value an investment or hire a third party to do it for them. They don't need to have any reliance on the credit rating firms.

It addresses the reform of Fannie and Freddie by restarting the private label mortgage securitization market. With the private label market unfrozen, Fannie and Freddie's portfolios can be run off.

There were lots of heated debates before passage of Dodd-Frank, but no disagreement from anyone in the administration or Congress about one thing. The bill had to end the possibility that American taxpayers would ever again have to bail out a big bank because its failure would have a severe impact on the entire economy.

You would think that by now at least that problem would have been addressed. But it hasn't been.

Eliminating the need for taxpayer bailouts won't occur until banks are required to provide ultra transparency and disclose their exposure details. It is only with this data that market participants can limit their exposure to each bank to what they can afford to lose given the risk of each bank.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.